The Hindu Business Line : Municipal financing: Separate social equity from commercial governance

Only a handful of municipalities have raised funds through bonds. Systemic issues such as internal accounting systems, revenue collection structures and lack of project planning may have something to do with it.

MR ANIL LADHA, HEAD, DEBT CAPITAL MARKETS, ICICI SECURITIES.

Raising finance for urban renewal and civic projects has become an important issue both for cities that require massive funding and the debt market that is literally waiting to be tapped. Some cities such as Ahmedabad and Bangalore have tapped the market, but given the nature of funding required for various projects and the debt market the full potential has yet to be realised. Mr Anil Ladha, Head, Debt capital markets, ICICI Securities, spoke to Business Line on some of the issues that need to be sorted out for cities to raise funds through bonds.

Excerpts from the interview:

Under the Jawaharlal Nehru National Urban Renewal Mission, local bodies have to raise 40 per cent of the Rs 30,000 crore envisaged for urban renewal with the Government providing the balance. How will urban bodies raise their share? From banks? Capital markets?

Urban Local Bodies (ULBs) can tap the capital markets to raise their portion, that is Rs 12,000 crore, of the funding. The debt capital market has enough depth to provide efficient structuring solutions for mobilisation of these funds at optimal cost.

Generally ULBs would require medium- to long-term funding for 7-15 years' tenures depending on the nature of the infrastructure to be funded. Banks, insurance companies and provident funds would be the key investor segments which could be targeted. These investors primarily require a creditworthy structure, that is, an established and transparent system of assured cash flows that can withstand political or public policy volatility, ad hoc user charges and leakages in revenue collections.

So far, the 13 issues have accounted for a mere 0.1 per cent of the bond market. What has been the experience of the cities such as Ahmedabad that raised debt in the bond market?

Ahmedabad municipality has been one of the savvier ULBs, having tapped the market couple of times with credible escrow mechanisms backing up the borrowings. Only a handful of municipalities have raised funds through bonds. But this issuer segment has been slow in using this funding route and I suspect systemic issues such as internal accounting systems, revenue collection structures and lack of project planning may have something to do with it.

So are you saying that some municipalities may not be able to tap this market? And that existing institutional mechanisms for revenue streams are not adequate to raise this kind of debt?

Generally, municipalities have raised funds against escrow of general revenue stream of the civic body, for instance, local tax collections that are more or less assured revenues and thus serve as adequate guarantee. That would have to continue till such time the facility being launched can generate robust revenues and, this is most important, a system for collection that is open and transparent can be put in place. Once this happens, funds can be raised on the strength of the project's cash flows. In the long run, project-based structures would be more practical and optimal than using escrow mechanisms to back up the borrowings.

Basically, the idea is that till such time projects generate stable cash flows, a civic body tapping the market needs "credit enhancement structures" at least in the initial period The escrow of general revenues is one source of guarantee; the other is external, say, banks or multilateral agencies such as the World Bank, ADB or IFC. If civic projects get social sector priority status, then banks would certainly be interested, at least as part of the credit enhancement structure to start with.

What in your view are the changes that would have to be introduced to make debt an optimal choice for raising funds?

Giving civic projects priority status to start with. Clearly spelt out tax benefits for investors can provide a big fillip to the use of debt by ULBs. Tax breaks would also entice banks to lend in a big way; since projects would be funded primarily through debt, lowering interest rates would ensure a certain level of viability. In the overall interest rate spectrum, costing for ULBs should be according to the prevailing rating-yield matrix. However, given their tax-free nature, these funds would be cheaper than all other forms of debt borrowing.

So you think the ULBs have all the powers they need to tap the markets? What is missing to make them accountable, responsible and transparent to the investor from a legislative point of view?

Of course in the long term, some key changes are required in the overall governance of ULBs. While complete autonomy and privatisation of such bodies may be impractical, governance based on commercial principles would be highly desirable.

There has to be a segregation of the social equity administration from commercial governance of projects. This is the most important issue to be tackled before tapping the market.

For now, ULBs have both local taxing and legislative powers to at least generate some streams of robust revenues that can cross-subsidise, if you wish, the cash flows of new projects for which the ULBs need funding. What they need to do is to evolve credible governance of the projects on commercial lines, free revenue generating mechanisms from legislative meddling. City budgets need to be transparent and clear accounting standards established. And most important, civic structures must be accountable and from the investor's point of view, actionable.

What has been the international experience on local bodies tapping debt markets?

American cities are a good case study to learn from. The local bodies have access to funding through tax-free instruments. They can easily access large pools of funding through various investor segments. In developing countries, local bodies have used multilateral funding sources and structures in accessing institutional funding.

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